Bond Outlook September 5th

The concept of the monster’s two heads (housing and credit squeeze) and a tail (carry trade) reminds us that concentrating on just one head, currently the credit squeeze, can easily allow the other head to sneak up and strike. However, let us begin with the credit squeeze head, return to the housing head and, for this week at least, not worry about the tail.

Libor being significantly above central bank target rates is the sure sign of banks’ reluctance to lend to each other. Their preoccupations are twofold:

• Inability to sell down their underwriting commitments
• Demand for loans to corporate customers when commercial paper (CP) cannot be rolled over

The actions of the central banks are addressing the current credit squeeze problem, and seem gradually to be succeeding. When the crisis is over, which will be measured both by a fall in Libor and the freeing up of the CP market, the relationship between risk and reward will have been revised and credit controls greatly strengthened.